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Germany may need an electricity capacity market – but not yet

A Frontier study published today, alongside a study by Professors Cramton and Ockenfels, contributes to the ongoing debate about whether Germany should introduce a capacity mechanism to incentivise investment in new power plants, and finds that while it may be beneficial in the future, currently the costs would likely outweigh the benefits.

The study responds to growing concerns in several European countries that electricity markets, which currently trade units of energy rather than capacity, provide insufficient incentives for the new plant investment required to ensure a reliable supply of electricity. Various governments, including those in UK and Germany, are now considering whether to introduce capacity mechanisms to create an extra revenue stream for investors.

The Frontier (Europe) study uses international case studies to illustrate the practical challenges of implementing capacity mechanisms. Frontier’s study finds that some of the factors that make capacity markets desirable do prevail in Germany. However, these potential benefits need to be weighed against a number of likely costs, such as those that would result from the imperfect practical design of the complex regime. The study finds that Germany has sufficient prospective capacity margins, even after the accelerated phase out of nuclear capacity, and that consequently these costs of introducing a capacity mechanism in Germany are currently likely to outweigh the benefits.

In a conceptual study, Prof. Peter Cramton (University of Maryland) and Prof. Axel Ockenfels (University of Cologne) outline the economic justifications for capacity markets and develop a reference model for such a mechanism.

Both studies were commissioned by RWE. The studies and a related article recently published in the German energy journal "Energiewirtschaftliche Tagesfragen" are available on request.

Frontier regularly advises on aspects of market design in energy markets and other sectors.

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